Treasury and banks kick-start home financing tool

Treasury Secretary Henry Paulson at the Treasury Building in Washington, July 13, 2008.

WASHINGTON (Reuters) - The Treasury and the nation's four biggest banks on Monday said they will kick-start a market for an investment product to support home financing in the latest effort to spur a slumping housing market.

Bank of America (BAC.N), Citigroup (C.N), JPMorgan Chase (JPM.N) and Wells Fargo (WFC.N) said they planned to begin issuing covered bonds, which are secured by pools of assets like home loans.

And the Treasury released a set of "best practices" for covered bonds, in a move designed to help develop the market for the investment instrument.

"The key to the U.S. economy making a major improvement will be turning the corner on housing finance and on the housing correction," Treasury Secretary Henry Paulson told a news conference. "We're not going to be able to do that unless we have availability of mortgage financing, and this is an attractive resource for mortgage financing."

The U.S. housing market has traditionally been supported by mortgage-backed securities, which involves bundling loans into securities and selling them to investors worldwide. Financing, however, has dried up since the wave of foreclosures spawned by the collapse of the subprime mortgage market last year.

Unlike mortgage securities, which pass all the risk to investors, covered bonds collateralized with mortgages would continue to perform even if the mortgages backing them default -- as long as the bank remains solvent.

Covered bonds are widely used in Europe but have only become attractive in the United States since the segment of the mortgage securitization market driven by investment banks dried up last year.

"I think there'll be some issuance very soon," Paulson said. "There's not 100 percent certainty that it ever will become very significant but this is an innovative tool and we think it's one that we think is very promising."

Officials from the four banks, said in a statement, "We look forward to being leading issuers as the U.S. covered bond market develops."

Covered bond loans stay on the balance sheet of the bank that issues the bond, so they are obligations on the bank. The issuer retains control of the assets that back the loans, which will be high-quality home mortgages in good standing.

Covered bonds are not totally new in the United States, but have been a small factor in the nation's $11 trillion home mortgage market that Paulson thinks can become bigger with the backing of the four big banks.

A Bank of America official said that, given time, covered bond issuance might reach $1 trillion, enough to be considered significant part of the mortgage market.

Whatever it amounts to, Paulson made clear that any new source of mortgage financing was welcomed given the seriousness of a housing downturn that is rated the worst since the Great Depression.

Two weeks ago, the Federal Deposit Insurance Corp. had offered guidance specifying how investors would get their collateral if an issuing bank failed, and the Treasury put together the set of best practices in the hope of further encouraging the market's development.

Federal Reserve Governor Kevin Warsh told the news conference the U.S. central bank was willing to consider highly rated, high-quality covered bonds as collateral for banks seeking emergency funds from the Fed.

"A covered bond framework may attract investor interest and facilitate greater access to mortgage credit," he said.

Some analysts, however, were skeptical covered bonds would be the answer to the housing market's woes.

"Absent of (lowering) the capital requirement on covered bonds, which would put them on the same footing as agency mortgage-backed securities, this is like exercising on a stationary bike," said Michael Youngblood, principal and portfolio manager at Five Bridges Capital in Washington.

The Securities Industry and Financial Markets Association, a bond market industry group, said a dedicated U.S. covered bond trader would be appointed within each of its member firms and those institutions would provide price information to electronic platforms for covered bonds -- steps that could help the market develop.

In another move to jump-start this market, Bank of New York Mellon (BK.N) said banks can use covered bonds as collateral for its repurchase program.

(Additional reporting by Richard Leong in New York and Mark Felsenthal in Washington; Editing by Leslie Adler)